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Kalpataru Bandopadhyay Souvik Kumar Bandyopadhyay
Overall risk of a bank depends on many factors. In this paper, we investigate how group characteristics and bank-wise individual factors (credit policy, extent of hedging) influence the risk of a bank and how they vary with time. Initially we used coefficient of variation and K-means cluster analysis to explore the nature of the data. Further, we attempted a mixed modeling strategy to model the net interest margin values, treated as a surrogate of the exposed risk of a bank. The estimates of mixed model suggested that although there was an observed group-wise disparity in the level of risk, risk is more sensitive towards the individual characteristics of the bank. It was also observed in the study that the temporal effect on group-wise characteristics and individual bank characteristics is minimal in determining their influence on the exposed risk of a bank. The study indirectly demonstrates why Indian banks are almost unperturbed even in the backdrop of collapse of big banks in US and Europe. Key words: Coefficient of Variation (C.V), cluster analysis, mixed model, net interest margin (NIM), Panel Data, Risk
Introduction Risk might be defined as uncertainties arising out of adverse impact against the expected outcome on the basis of planned objective. The standalone profitability of a business entity is not very meaningful unless it is accounted for along with risk. Banks are no exception. Banks are basically financial intermediaries which are confronted with several types of risk. After economic liberalisation, banks were open to discriminate pricing policies and offered differential products which carry different types of risks not dealt with by the banks previously. We understand that a transition of risk profile of the banks has taken place and thus, the importance of risk management and risk analysis has increased. Again, for the implementation of BASEL II, a robust integrated risk management system should be required in place for each bank. In the year 2000, there were one hundred and two scheduled commercial banks comprising State Bank of India (SBPSU) and its seven subsidiaries, nineteen Public Sector Banks (PSU), forty-two foreign banks and thirty-three Indian private banks. However, as on 31st March, 2007 only eighty eight banks reported to the Reserve Banks of India. During the period, the group comprising of SBPSU and PSU has increased from twenty-seven to twenty eight due to the inclusion of IDBI Ltd. On the other hand, in India, the number of New Private Banks (NPVT), Old Private Bank (OPVT) and Foreign Banks (FOR) reduced by fifteen. There were a few cases where merger like Global Trust Banks and ANZ Grinlays had
Kalpataru Bandopadhyay, Natunpally East, Ambagan, P.O. & Dist: Burdwan – 713101, West Bengal (Email: firstname.lastname@example.org) Souvik Kumar bandyopadhyay, Dept. of Statistics, Memari College, Burdwan, West Bengal (Email: email@example.com)
Decision, Vol. 37, No.3,December, 2010
Risk Analysis of Scheduled Commercial Banks of India
taken place but those do not explain the whole situation. Again, the mergers in both the aforementioned cases were caused by inefficiency in operation. The other banks that have not reported their accounts for the year 2006-07 to the regulatory apex body, which is mandatory, either stopped working in India or their accounts were not in a position to be submitted even up to 31st March, 2008. Thus, from the reduction in number of banks we can perceive that risk intrinsically lies in the banking business. We have conducted a comparative analysis of total risk of bank at group level as well as individual level on the basis of study of variation in Net interest margin. The paper is organized as follows. In the following part of this section, we define the various facets of risks associated with banking environment. In the next section, we present a literature review of the work done in this area both in the context of India as well as internationally. The third section describes the data and the methodology as well as the analysis used. Interpretations are discussed in the fourth section followed by a conclusion. Comparative Analysis The assessment of risk in absolute terms would not be very meaningful. In fact, Beckers (1998) commented that risk is always a relative concept and managers are continuously evaluated against their peer group. The absolute risk analysis leads to risk inherent in the benchmark and the active risk added on the benchmark by the respective manager. So, the absolute quantification of risk turns out to be unreliable. Thus, an attempt has been made to compare the risks among scheduled commercial banks of India. A bank has to deal with various types of risks. These are broadly divided into credit risk, market risk, liquidity risk, operational risk etc. Again, all these risks club into overall risk or total risk. Total Risk and Risk Philosophy A bank like any other business entity sets its risk tolerance according to its risk philosophy. A firm should ensure that plans related to risk-bearing activities coincide with or complement other aspects of corporate business. The actual management of risks tends to occur at a desk level or business unit level. A firm should review the totality of its risk when seeking to define its risk philosophy. By verifying how total risks might act to affect total operations, it could define its tolerance level with greater accuracy and can define risk tolerance in different units and functional levels. A review of risk at individual enterprise level can reveal important macro considerations during a critical point in the risk philosophy phase (Banks, 2002). There are two broad approaches for developing risk management strategies (Hull, 2007). One approach is to identify risks one by one and handle each separately. There are various types of risks a bank has to deal with. These are broadly divided into credit risk, market risk, liquidity risk, operational risk etc. Again, all the risks can be divided into further sub-classes. This is sometimes referred to as risk decomposition. There are a number of techniques to assess the different kind of risks. The other approach for framing risk management is called risk aggregation. Sadakkadulla (2001) conducted a theoretical study on an integrated risk measurement framework. He arithmetically added three types of risk, viz. market risk, credit Decision, Vol. 37, No.3,December, 2010
Vol. r g s c i = = = = = Overall risk of a bank Global level risk Sovereign risk Risk characterised by different group or category Risk specific to an individual bank There is hardly any economy in the world which is now insulated from global economic movement. s. Dembo (1998) observed that one cannot take Risk Metrics value and add it to Credit Metrics value and obtain a risk statistic that combines credit and market risk. The different group of banks are promoted and managed by different kinds of promoters. (2006) found that geographical diversification does not affect risk of a bank. Kumar et al.December. risk at country level. Again. arithmetical aggregation does not take into account the power of diversification arising out of existence of negative correlation among different kinds of risks.3. Decision. In this paper. i) where. al. (2007) commented that different categories of risk are interdependent and overlapping. However. at the bank level. The global level risk is almost equivalent for all the banks in India. risk at global level. Here. The total risk could also be analysed from the viewpoint of various layer or levels. 37. We do not subscribe to the idea of combining different functional risk to find out total risk. Levels of Risk The existing literature has assessed risk at the micro level i. The sovereign risk is almost equivalent for all categories of banks in India except for the foreign banks whose impact on sovereign risk might be less because of their operation networked in different countries. The risk of an individual bank could be divided into four levels viz. In fact. instead of managing the individual functional risk on a standalone basis. an attempt has been made to compare the total risk of different scheduled commercial banks.e. we observe risk from the macro level and then analyze at the bank level. in this paper. As such the risks must not be viewed and assessed in isolation not only because a single transaction might have a number of risks associated with it but also because one type of risk triggers other risks. He observed that the methodologies for generating scenarios might not be compatible. So. risk at group level and risk at individual level.Risk Analysis of Scheduled Commercial Banks of India 50 risk and operational risk to arrive at the overall risk estimate. Rather. c. Federal Reserve has approved the procedure for adoption for internal risk management. In such a case combination of individual risk might not be exactly the same as the overall risk of banking business. 2010 . it is possible that they have different philosophy as far as risk appetite is concerned. a bank should monitor its individual risk in such a manner that the overall risk does not go beyond control. In USA. No. Choi et. r = f (g. However. These studies have carried an analysis taking one particular aspects of risk.
we took resort to an overall indicator that would reflect the risk directly or indirectly for all the banking activities it carries.e. the higher the NIM will be. Chirstos and Geoffery (2003) also observed that characteristically non-interest income was more unsTable than interest income in other countries as well. 2004) observed that less than 17% of the total income arises out of non-interest income in India. it might be considered that the risk undertaken by bank has increased. A survey (Ramsastri et al. As there is problem of additive measure. continuous addition of fresh capital especially in last two-three years by many of the banks in India improves the asset base and as such the net income might have increased but the risk undertaken by them might be same. 2010 . Again. So. economic equity ratio and unsecured advances to total advances are characteristically different for different category of bank. So.3.. As such we prefer variability of NIM over net interest income to be treated as a measure of risk form. we have considered closing total assets instead of average total assets as prescribed by Reserve Bank of India.December. on interest income. Any non-stochastic statistical application would not be very meaningful under that circumstance. Variation of Net interest margin (NIM) The net interest income is defined as the difference between total interest income over total interest expenses. Net Interest Income = Total Interest Income – Total Interest Expenses The Net interest margin (NIM) is defined as net interest income divided by average total assets. Net interest margin = Net Interest Income / Total Assets = (Total Interest Income – Total Interest Expenses)/Total Assets If net interest income fluctuates without adding any other assets. variability of net interest income might not adequately manifest the risk. But. non-interest income is in no way within the principle activity of a bank. Therefore. The higher the spread. But. Decision. due to continuous introduction of new services and severe competition the non-interest income changes randomly. variation of NIM might be a better parameter to assess risk. a bank cannot survive depending only on its non-interest income. however. 37. 2007) have observed that variability of net interest income (NII) or net interest margin (NIM) as the indicator of risk. In our article.. In fact. Vol. We understand that the decline in net interest income (and Thus. No. On the other hand.Risk Analysis of Scheduled Commercial Banks of India 51 Laeven & Levine (2006) observed that their sample of the largest banks in each country demonstrates that ownership and management structure exerts influence on risk taking. The net interest income of banks mostly from the spread maintained between total interest income and total interest expenses. we have considered assessing the risk inherent in the principle income component of banking activities i. We found that several components like the unsecured advances to total advances. Total income of a bank consists of interest income and non-interest income. we cannot add up different risk component to arrive at total risk. unapproved securities to total investment. Again. Thus. NIM) increases the risk. For this many authors (Kumar et al. Smith. The non-interest income does not have any definite line of operation.
the main function of the financial management of the bank is. both upward and downward departure of NIM from the average might reflect the increase in risk. Instead of total spread. Morgan Chase. Evanoff and Wall (2001) found that sub-debt yield spreads as bank risk measures has higher prediction error and further work is required to refine the risk measure. coordinated and managed as an integral system to control the interest income and expenses and the resulting NIM on an ongoing basis. Finally. He reported the standard practices and evaluated how and why it is conducted in the particular way chosen. in this paper. There are some studies that dealt with different issues of risk in banks. Jaschke (2002) and Saita (2007) found the limitations of VaR. optionpricing models. Anthony (1996) reported about several risk management techniques in the banking industry. Vol.Risk Analysis of Scheduled Commercial Banks of India 52 in a competitive environment. therefore.) to tackle the issue of risk in business activities. The variability of NIM reflects all sorts of risk together a bank is concerned with. much less attention has been focused on how VaR and the risk-adjusted performance measures [such as RAROC] are to be used to manage risk. Birchler and Hancock (2004) provided evidence that a bank’s subordinated debt yield spread is not by itself a sufficient measure of default risk. Macdonald (1998) described the scope of carrying out quantitative monitoring of banks on the basis of consolidated financial statements and off-balance sheet item.December. value-at risk (VaR) has been developed to measure portfolio risk of a business entity. Robinovitch (1989) found that the banks in his study have very low insolvency risk. 2010 . to manage NIM to ensure that its level of risk is compatible with risk-return objective of the bank. 37. concept of beta. The increment in NIM might be a result of acceptance of higher risk level. some authors considered partial spread. cross asset risk exposure etc. He also mentions the elements missed in the existing methodology. Some of these techniques and models had been used to assess the risk of banks as well. P. in other words. interest income is the core banking income of a bank. The banks preferred VaR to measure the market risk and portfolio risk. Kotrozo Decision. The financial management of a bank views the risks as a set of interrelationships that must be identified. spread will be thin. Literature Survey There is some literature on risk measurement in the field of business. Later on several techniques and models were developed (e. Applying option-pricing model. credit link swap. All the risk that is undertaken for the core banking activities should be reflected finally in the net interest margin either directly or indirectly. before 1970’s risk management was largely based on experience and judgment. So. So.g. concept of standard deviation. in the long run. However. competitive and would not allow earning above normal return and hence. No. we are focusing on the variability of NIM. at least. above average NIM would imply involvement in the activity with greater risk exposure. interest swap.3. During mid-1990’s at the initiation of J. So. Saita (2007) is of the opinion that while the highly technical measurement techniques and methodologies of VaR have attracted huge interest. He concluded that bank supervision must respond to the challenge of new developments for banks and consequent additional risks they represent for depositors.
After deregulation. the stability of income of commercial banks has improved during the period 1997 to 2003. Demonstrating a comparison between long-term and short-term risk models for US and UK markets. No. 37. In India. Data & Methodology The dataset consists of measurements of NIM of eighty eight Indian banks categorised into five groups. They further observed that competition fosters the willingness of banks to lend. among one of the very few studies in this field. NIM values for each bank were obtained for all the quarters between periods 2000-2001 to 2006-2007. It is the derivative of fluctuations of some parameters. we dealt with data spanning for as high as twenty-eight quarters.3. 2010 . Vol. In mixed model. Ramsastri et al. Rao & Ghosh (2008) rightly pointed out that India banking sector is still in its preparatory stage in implementing a sound operational risk management due to lack of quantification. Chattopadhyay & Mazumdar (2006) conducted a study on seventeen banks and concluded that the risk of PSU banks have come down significantly while Indian Private Banks assumes to be more risky. The methodology adopted by this paper is as follows: Decision. Boyd et al. On the basis of extensive ratio analysis. Das (1999) attempted to measure risk preference of different categories of banks. On the other hand. Smith. Hence. Morton et al.Risk Analysis of Scheduled Commercial Banks of India 53 & Choi (2006) used Herfindahl Index (HHI) to measure diversification and found that total risk is increased for those banks that focused on their revenue activities. All the data have been collected from Reserve Bank of India web site [http:// www. Bandopadhyay & Dutta (2006) assessed risk and found that the risk level is low in case of PSU Banks in comparison to Indian private banks. there is no serious study to analyze the overall risk of a bank.December. it would be possible to capture the random effect generated by the group and by the respective individual bank which in turn would help to have the risk analysis with more accurate predictive value. Hence. Chirstos and Geoffery (2003) demonstrated the relationship between non-interest income and income stability. (2006) observed that there is no relationship between the bank’s risk of failure and concentration. Some NIM values were not available mainly because some banks stopped working in India which results the dataset to be unbalanced. Sadakkadulla (2001) arithmetically added up different types of risk to find out overall risk. there is dearth of studies on risk of banking. Risk cannot be measured directly. Beckers (1998) found that the explanatory power of a long-term risk model is significantly higher than the short-term risk model.in]. in this paper our endeavor is to compare risk of different categories of banks using the mixed model approach.org. (2004) had conducted a study on scheduled commercial banks and concluded that though average net interest income declined. (2005) introduced a general and flexible framework for asset allocation to manage risk using Monte Carlo techniques. In India.rbi. Ghosh et al. DeYoung & Roland (2001) conducted a study on different product mix and earning volatility of commercial banks using leverage model. On the other hand. (2008) analysed the firm specific abnormal returns using cross-sectional regression.
111 ( 0. The net interest income may vary widely due to the size of the bank. we used coefficient of variation (C.056 ( 0.842 ) 2.V.V.768 ) 2.946 ) OPVT 2.829 ) 2. Analysis The group wise and year wise mean and standard deviations of the NIM values are reported in Table 1.765 ( 0.344 ) 3. NIM itself is a standardized measure as far as size is concerned.Risk Analysis of Scheduled Commercial Banks of India 54 (i) In the first subsection. PSU banks and SBPSU banks are on the higher side ranging from 2. 37. On the contrary. To find out more about the variation in a concrete manner.342 ( 0. we calculate group-wise NIM and its standard deviation to compare risk among different group of banks. No.526 ( 0.999 ) 2. The C.613 ) PSU 2.452 ( 0. The standard deviations of NIM of both types of private banks were in between 0.983 ( 1.319 ) 3. So.171 ( 0.631 ) 2. (iv)The final subsection reports application of Mixed Effects Model to quantify the extent of variation due to the group and also measure the extent of variation due to individual characteristics of the bank.281 ) Group wise and year wise mean and standard deviations of Net interest margins Indian banks.687 ) 2. But.291 ) 2.197 ) NPVT 2.039 ) 3.142 ( 0.December. Figure 1 shows the bar diagram representing our findings. Figure 1 shows some interesting findings.075 ( 0.007 ( 0.347 ) 2.687 ( 0. of NIM for foreign banks and private sector banks (both new and old) are predominantly much higher than that of public banks (both for PSU and SBPSU).622 ( 0.619 ( 1.794 ) 1.746 ( 0.623 ( 0.258 ( 2.504 ) 3.848 ( 0.0 whereas the same data for PSU banks and SBPSU were never above 0.289 ) 2.532 ( 0.195 ) 2.709 ) 2.929 ) 2.363 ) 3.9.8 or below during the period of study. Table 1 YEAR 2000-2001 2001-2002 2002-2003 2003-2004 2004-2005 2005-2006 2006-2007 FOR 3. The higher the variation in NIM. Vol.173 ( 1.363 ) SBPSU 3. of foreign banks has a declining trend. We obtained the C.434 ( 0. of PSU and SBPSU banks have also declined marginally Decision. higher is the risk of that bank.743 ( 1.380 ) 2.075 ( 0.825 ) 2.617 ) 2.834 ( 0.355 ( 0.431 ) 2. (ii) In the second subsection.714 ( 0.3.4.997 ( 1.600 ) 2.7 to 3. It is further observed that C.877 ( 0. standard deviations of NIM of foreign banks were never below 1. 2010 .943 ( 0.030 ) 2. we compute the coefficient of variation and perform Analysis of Variance (ANOVA) to confirm group level risk.373 ) 3.999 ) 3.376 ) 2.736 ) 2.V.689 ) 2.724 ( 0.99 ( 0.142 ( 1. of NIM for each year of each group.). The figure in the brackets indicates the standard deviations. The C.3.943 ( 0.V.365 ) 3. (iii) Cluster analysis to verify individual bank level variation of NIM within a group is performed in the third subsection.583 ( 0.6-0. We observe that year wise mean NIM for Foreign banks.163 ( 0. standard deviation itself is a decent measure to capture deviation and to compare risk among different group. But the mean NIM of NPVT and OPVT banks are at 2.V.
90 2. 1959) without replications at 95% level of significance on the NIM values.3.December.42 0. 13 21 . No.Risk Analysis of Scheduled Commercial Banks of India 55 over the period. 24 4.32 5. We understand that the PSU banks remain in the least risk domain where as the new private banks are most risky. But the variation of their NIM of both types of private banks has almost no trend. 2.14 0.M .19 C. 37.16 0.V. 2010 . Table 3 shows the results of ANOVA. 83 6. Figure 1 Bar diagram of year wise Coefficient of Variation of the bank groups Now let us combine the average NIM.97 3.86 2. Decision. The two factors taken were groups and years. Table 2 G ro up Net interest margin during 2 001-2 007 A.61 1.D. 44 SBPSU PSU OPVT NPVT FOR Combined standard deviation and Co-efficient of Variation of Net interest margin We further went on to perform two factor analyses of variances (ANOVA) (Scheffé. their standard deviation and coefficient of variation taking all the twenty-eight quarters at a time. Vol. 0.49 S. 5.15 0.
None of the bank group solely forms a composition of the cluster. 2010 .December. We do not go into the details of the clustering algorithm but describe the steps involved and K-means method at the note-1. we carried out 5-mean cluster analysis. To check whether there exists individual level variation. If the individual level variation of banks did not exist.14 0 . Vol. No. there is exist individual level variation of the banks. Cluster analysis is the class of procedures to separate component data into groups. Table 4 Cluster composition obtained from 5-means cluster analysis Group FOR NPVT OPVT PSU SB PSU TOTAL Cluster-1 5 0 0 0 0 5 Clust er-2 5 2 3 3 1 14 Cluster-3 4 0 1 10 5 20 Cluster-4 8 4 4 0 0 16 Cluster-5 6 0 9 6 2 23 TO TAL 28 6 17 19 8 78 Decision. 1974 and Johnson & Wichern.979 0348 0. then we expect that banks of same group should fall into one cluster. However as is seen from Table 4. we went on to check whether the NIM values are affected by individual bank level variation. The goal in cluster analysis is to arrive at clusters of objects that display small within-cluster variation relative to between-cluster variation. we performed K-means cluster analysis (Everitt.0007 5 . we carried out K-mean cluster analysis using the statistical software MINITAB.000 1538 - Table-3 ascertains that there exists statistically significant group level variation (P-value <0. Since we had five groups.000 788 6.2 6 68.Risk Analysis of Scheduled Commercial Banks of India Table 3 Analysis of Variance Table for the NIM Source Variation Year Gro up Error 56 of Sum Squares 0 .55 1.12 of Degrees Freedom 1 4 58 6 of Mean Sum of F Squares 0. 2001).3. With this notion.05). 37.7443 - p-value 0. After confirming the group level variation.0007 88 2 6.
In financial data analysis. an analyst confronts a situation where multiple measurements (returns/ profit /interest etc) are obtained from each subject (bank/portfolio etc) at different times and possibly under different conditions. On this modified NIM data we carried out 3-mean cluster analysis. The pertinent question is to infer about the extent of variation and quantification of the variation by finding out the group level and bank within group level variance. We take the advantage of the fact of two special characteristics of the data. 2003). we slightly modify our data set by merging the • new private banks and old private banks as a single group and denoting the group as private sector banks (PVT) • State banks and public sector banks as a single group and denoting the group as public sector banks (PSU) Thus. The main interest of such panel data is usually in characterizing the way the outcome changes over time. The NIM within various private banks is also inconsistent to some extent. 37. we had a modified data with the same number of banks and three groups. and cluster analysis confirmed the presence of variation between groups and between banks in a group. we used panel data which is the combination of time series with cross-sections data and can enhance the quality and quantity of data in ways that would be impossible using only one of these two dimensions (Gujarati. Both C. 1995) structure. Both these features can be exploited using a mixed model.December. The NIM of PSU banks forms a pure cluster demonstrating the consistency within the group.V. The NIM of foreign banks is widely dispersed. A mixed-effects model (Laird & Ware. The NIM data is a panel data containing a multilevel or nested grouping (Goldstein. 2010 .Risk Analysis of Scheduled Commercial Banks of India 57 Noting the fact that there are only six and eight banks in the new private bank and state bank groups respectively. Table 5 describes the results obtained from the analysis. and the predictors of that change. For this we further analyze the data using mixed models. Table 5 Cluster composition of 3-means cluster analysis on the modified NIM data GROUP FOR PSU PVT T OT AL Cluster-1 5 0 0 5 Clust er-2 14 27 14 55 Clust er-3 9 0 9 18 TOTAL 28 27 23 78 There are some revealing results in Table 5. Vol. In this study. A note on panel data and its applicability for our study can be had in note 2.3. The composition of cluster-1 did not change from that of Table-4 but the most significant change comes in cluster-2 where all the twenty seven public sector banks belong. 1982) is a widely accepted approach to analyse the Decision. No.
nk) bank at jth period (j = 1. NIMijk = (ȕ 0k + b0ik ) + (ȕ 1k + b1ik )t ij + İ ijk ……… ………… Where …………………(1) NIMijk = ȕ 0ik + ȕ1ik t ij + İ ijk ……………… … … (1) ȕ0ik and ȕ1ik are the individual intercept and slope of the ith bank belonging to the kth group. It is quite reasonable to presume that the observed NIM is subjected to two levels of variations. between group variation. The mixed model approach is to simply write out a single regression model for each observation. 2010 . Let NIM ijk denote the NIM measured from the ith (i = 1. Both within and between-subject errors are assumed independent from subject to subject. (2) and (3) the full model is Decision. The model has the usual linear regression predictor for the mean response.….e. All of the observations on the same subject will have the same between-subject errors. ȕ 0k and ȕ1k are the intercept and slope for the kth group while b 0ik and b1ik are the random intercepts and slopes for the ith bank belonging to the kth group.5. the within group variation and the other is the variation in the banks of the same group i. One is the variation between the different groups i.…. their within-subject errors will differ. Thus.Risk Analysis of Scheduled Commercial Banks of India 58 combination of time series with cross-sections. ).2…. observations on different subjects are independent. No.. Vol. but has two types of random error terms: between-subject errors and within subject errors. 37. Using (1). In equation (2) both the individual intercept and slope is divided into two components. Furthermore the group level slope and intercept can be decomposed as (3) ȕ 0k = ȕ 00 + b 0k and ȕ 1k = ȕ 10 + b1k ………………………… …… (3) ȕ 00 and ȕ 10 represents the fixed effect regression estimates of the intercept and slope and b 0k and b1k are the random intercepts and slopes for the kth group. 2. and can be correlated within a subject.e.December. The linear mixed model relating NIM ijk with t ij incorporating the above variation is (2) …… (2) or. tik) of the kth categorized group (k = 1.2.3.
.ı 2 ) We assume that both matrices b k and b ik follow a bivariate normal distribution with covariance Ψ1 and Ψ2 respectively.1862 0..... The mixed model analysis of the data has been performed using the ‘lme’ function of the “nlme” package (Jose Pinhero et al..3. We take t ij to be the years centered at 2000 i...e. 2007). Vol.. We assume Ψ1and Ψ2 to be symmetric and positive definite only.December.. we do not assume a special structure for Ψ1 and Ψ2 ..... Also.0012 Standard Error 0. No. Table 6 Fixed Effects ȕ 00 ȕ10 Value 2... a normal distribution with zero mean and variance for i... İ ijk are assumed to be independent assumed to be independent for different i... ...... bik is the bank within group level random effects model.. j and k and of the different random effects. 2007) for the statistical software system R (R development core team. ~ b1k b bik = 0ik ~ N 2 (0....group error is assumed to follow ı 2 ...... Ψ1 )...... b k is the group-level random-effects vector. 37.... 2010 ..... Ȍ2 ) ~ b1ik and İ ijk ~ N(0...808 0..(4) with theassumption s that b b k = 0k ~ N 2 (0. .9488 Fixed effects estimate of model described in equation 4 Decision..Risk Analysis of Scheduled Commercial Banks of India 59 NIMijk = (ȕ 00 + b 0ik + b 0k ) + (ȕ1k + b1ik + b1k )t ij + İ ijk … ……(4) .. t i j = yearij − 2000 ... bik are assumed to be independent for different k and are İ ijk the within.02469 P-value 0 0. k.
We carried out k-mean cluster analysis. After confirming the group level variation. intra group) level inconsistency.05755 0. we went on to check whether there exists individual (i. Interpretation & Discussions The coefficient of variation of foreign banks and private sector banks (both new and old) are higher indicating higher risk level than that of public sector banks. From the group level predicted (Best Linear Unbiased Predictor) random effects [see Appendix-1] we observed that foreign banks.Risk Analysis of Scheduled Commercial Banks of India 60 The evident feature is suggested by the fact that fixed effect of time has no impact on NIM as is been reflected by small estimate of ȕ 10 an insignificant p-value (0.9488) but the intercept has a statistically significant effect with p-value (0) less than 0. the rate of growth (slope) of NIM has a diminishing trend and vice-versa. which is quite high. both the intercept and slope are negatively correlated. denoted by Ψ 1 2 ˆ = 0.5290638.05. PSU banks and SBPSU banks have positive intercept and negative slope but NPVT and OPVT has negative intercept with positive slope. 37. The plotting of observed and predicted data shows a strong linear trend demonstrating higher degree of predictability. So. Again. if the entity (group or bank) has a higher NIM value (i.e. This finding is in consonance with Laeven & Levine (2006) that the ownership and management philosophy exerts influence on risk taking. Vol. None of the bank group solely forms a composition of the cluster under 5mean cluster analysis. The intercept variation is small for group level as compared to the intercept variation for the bank within group level. higher intercept). From the above estimates.897. On the modified NIM data we further carried out 3-mean cluster analysis.0005272087 -0.05755 ˆ = 2. In both cases the predicted random effects associated with intercept and slope is highly correlated in opposite direction.00001748587 0.0900127140 Ψ 2 -0. we found that there exists statistically significant group level variation.0306970562 The maximum likelihood estimate of ı came to be 0. 2010 .991 and the same for bank within group is -0. Decision.e.3. it can be observed that for group-level and bank within group level variation. The maximum likelihood estimates of Ψ1 ˆ and Ψ ˆ are and Ψ2 . No. Interesting findings were obtained for the random effects. In fact the estimated correlation between the intercept and slope group level is -0.00001748587 Ψ 1 -0. implying that most of the observed variation in NIM is major due to the banks and minor due to groups.0331668772 -0. With the help of ANOVA. the slope level variation for both (group level and individual bank level) the cases are small indicating that temporal effect has minimal existence in the variation of NIM.December.
Conclusion The performance of a bank from the viewpoint of profitability is not very meaningful unless the same is accounted for along with the risk. However. that the slope level variations (for bank level as well as group level) are very small indicating that time factor has minimal effect in the variation of NIM. in spite of remaining at comparatively high-risk domain after liberalisation. this paper cannot infer that the risk management of foreign banks and private banks are less efficient. But. This situation indicates the existence of competition in banking industry. We can corroborate the verity from Table-1. From the bank-wise risk analysis one can move forward to find out Risk-adjusted Return on Asset (RAROA) for each bank to assess that whether risk assumed by the bank is in commensurate with return they earn in comparison to its peers. The present study has taken variation of NIM to assess the risk. Ramsastri et al. the banks start accepting more risk in its operation for higher profitability and again when NIM gets higher. further research could be conducted taking different components of NIM to check how each component contributes to the overall risk measures. higher intercept). This phenomenon indicates existence of proactive risk management in place. However. The economic liberalisation has made the PSU banks more efficient (Rammohan & Roy (2004).) which might have intensified the competition in the banking sector. In fact. It is further observed from the group-wise random effects and bankwise random effects that the intercepts and slopes are highly correlated in opposite direction in both the cases. we intend to conduct a study to analyse the role of interest/discount on advances/bills and interest on investment in the overall risk of a bank. the study infers that the competition did not affect the risk of the industry significantly at least since 2000.e. This fact can also be corroborated from the bar diagram (Figure-1) where the dimension of the bars for public sector banks and state bank public sectors are more or less same in contrast to foreign banks and private banks. (2004) demonstrated that volatility in net interest income declined after economic liberalisation (1997-2003). It explains the fact that the banks with higher NIM as a whole were either deliberately forced to reduce the spread or their spread reduced following the law of normal rate of return. it is observed in our study. We understand when NIM gets reduced.December. the banks reduces its risk exposure even sacrificing its earning but there was no significant trend found in the period of study. mostly the variation is major due to operation of individual bank and minor due to the group they belong. Bandopadhyay & Dutta (2006). After economic liberalization. 37. The variation of NIM within Indian private banks is in between the variation of PSU banks and foreign banks. Chattopadhyay & Mazumdar (2006) etc. No. the rate of growth (slope) of NIM have a downward direction. But. 2010 . Vol.3. It implies that if the entity (group or bank) have a higher NIM value (i. the banks were free to introduce new products and free to charge price their products with varying risk Decision.Risk Analysis of Scheduled Commercial Banks of India 61 The finding of cluster analysis reveals that there exists bank level variation in the data and the public sector banks tend to be more similar on the basis of NIM whereas the NIM of foreign banks is the dispersed most. So. To assess the magnitude of variation in both the cases we applied Mixed Effect Models. It is observed that variation of NIM is caused by group level variation and individual bank level variation.
37.M. IMF. However. No. So. Standard deviation and co-efficient of variation of NIM of foreign banks and both types private banks are higher than both type of public sector banks and ANOVA confirms the existence of group level variation. Wharton Financial Institutions Centre Conference on Risk Management in Banking. Bank Risk Taking and Competition Revisited: New Theory and New Evidences. S. the interest rate has also changed several times forcing spread structure to change. Swiss National Bank. 2006. The Simple Rules of Risk: Revisiting the Art of Financial Risk Management. Working Paper no. Birchler. Wharton. Indian Journal of Public Enterprise. Social Science Research Network. This in turn proves prevalence of proactive risk management system in place in Indian Banking System. We considered NIM of all eightyseven banks categorized into five groups spreading over twenty-eight quarters staring from 2000. Reserve Bank of India Occasional Paper. Are Public Sector Bank Inefficient?.). A.2006. S. 2010 .. K . New York: John Willey & Sons. 2002. Das.Risk Analysis of Scheduled Commercial Banks of India 62 associated with the instrument. K. Working Papers No. Risk Management and Analysis. S. G. & Hancock. Kotrozo. Nicolo. It has also been found that risk arises due to individual level operation is more prominent than the risk arises due to group level variation. In this paper. Profitability of Public Sector Banks: A Decomposition Model. Commercial Bank Risk Management: An Analysis of Process. M . M. D. What Does the Yield on Subordinated Bank Debt Measure?. H. Boyd. Decision.1013430. the model suggests that the time factor has almost no impact on the variation of NIM. & Dutta.2006. Cluster analysis further substantiates the existence of bank level variation within the groups. & Mazumdar. Banks. and Choi. References Anthony. A. A Survey of Risk Measurement Theory and Practice. 2. (Eds. 2006. All these issues have enhanced the importance of risk analysis of a banking firm. A Comparative Analysis of Performance of the scheduled Commercial Banks in India during the Post-reforms Period. Vol. 1998. Diversification. U. Chattopadhyay. 27(2): 33-43. D. England: John Wiley & Sons Ltd.December. Bank Risk and Performances: A Cross-Country Comparison. and Jalal. instead of focusing on one component of risk we have made an attempt to analyze overall risk of a bank. WP/06/297. 20: 1. The model further indicates the existence of competition by demonstrating negative correlation between intercept and slope of NIM. J. W. 107-127. J. we understand that economic liberalisation might have increased competition but has not led to change the level of risk.3. A. During the period of study. 1999. 2004. The application of mix models validates the group level variation and individual bank level variation. The Institute of Cost Works Accountants’ of India. E. 1996. Working Paper No. 21:39. The Research Bulletin. Bandopadhyay. Beckers.
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S.3. 2010 . J. Preparedness of Indian Banks in Managing Operational Risk.. The data matrix is transformed into ‘n × n’ similarity or distance matrix (computed between pairs of objects across the ‘p’ measurements (variables)) Cluster formation using a clustering algorithm to form either a) Mutually Exclusive Clusters 2. ISBN 3-900051-07-0. R Foundation for Statistical Computing. and Ray. Saita. 2004. 2007. New York: Wiley. Economic & Political Weekly. 2008. Chirstos. Risk Measurement in Indian Banks — towards an Integrated Framework. IRA Bulletin. Scheffé. URL http://www. T. Economic & Political Weekly.Risk Analysis of Scheduled Commercial Banks of India 64 Ram Mohan. New York: Elsevier. The Analysis of Variance. R. Austria. T. 2001.2007.org. No. Decision. accessed on 30. 198. Rao. 43:18. Smith. S and Geoffery. b) Hierarchical Clusters Clustering algorithms are rules concerning how to cluster the objects into clusters on the basis of inter-object similarity.R-project.12. Vol. D. Reserve Bank of India Bulletin various issues (1995-2008). R: A language and environment for statistical computing. W. Comparing Performances of Public and Private Sector Banks.in. Non-Interest Income and Total Income Stability.C. 39 (12): 1271-1276. Vienna.rbi. R Development Core Team. P.org. We have ‘p’ measurements (variables) on ‘n’ objects (data matrix). 37. and Ghosh.) and ‘p’ = 7 measurements. T. 1959. 2007. Working Paper No. 2003. H. Bank of England http:// www. F. A variety of clustering algorithms have been proposed for cluster analysis purpose. For the above data we have ‘n’ = 78 banks (in fact we had 87 banks but ignored those banks from which one or more of NIM values were not available. Value at Risk and Bank Capital Management. 3. Saddakadulla.December. NOTES Note 1: Steps of Clustering Process: Any clustering process typically consists of the following three steps 1. 23(7): 22-25.
012040518 -0. 044311756 Slope (Year – 2000) -0. Vol.009940291 0. A K-means algorithm can be described as follows. • Step-3 Repeat step-2 until no more reassignment takes place.Risk Analysis of Scheduled Commercial Banks of India K-means cluster 65 MacQueen (1967) suggest the terms K-means for describing the algorithm that assigns each item to the cluster having the nearest mean. 008067985 0. Cluster composition changes. assign an item to the cluster whose mean is nearest to that cluster (Distance is usually computed using Euclidean distances). Note 2: The objectives of panel data analysis are to examine and compare responses over time. For example. time series data sets usually consist of a single. Step-2 Proceeding through the list of items. The defining feature of such data model is its ability to study changes over time within subjects and changes over time between groups. panel data models can estimate individuallevel (subject-specific) regression parameters and population-level regression parameters. Panel data sets differ from time series data sets because panel data usually consists of a large number of a short series of time points. Appendix-1 Bank Group-wise random effects Group-wise Random Effects Interc ept FO R NPV T OPV T PSU SBPSU 0. long series of time points.00558658 Decision.095503166 0. • • Step-1 Partition the items arbitrarily into K initial clusters. 121967982 -0. No. Recalculate the new mean for each cluster.01537706 0. 37. 2010 .3.00101717 -0.078844556 -0.December. On the other hand.
026623254 0.51416078 5. Oman International Bank S.77874252 0. HSBC Ltd.065852386 0.S.05648201 -4.391500574 0.Risk Analysis of Scheduled Commercial Banks of India Appendix -2 Bank-wise Estimated Random effects Bank Name ABN-AMRO Bank N. Antwerp Diamond Bank Arab Bangladesh Bank Ltd.66650636 -0.034678213 -0.47585595 -0.December.052955747 0.01962775 0.660073625 0. 2010 .3.454139507 -0.31391841 2.181436822 0. State Bank of Mauritius Ltd. ING Bank N.52500029 -0.376126413 -0. 37.100504055 -0.58741076 -1.123905514 -0.03868971 -1. Bank of Nova Scotia Bank of Tokyo-Mitsubishi UFJ Barclays Bank PLC BNP Paribas Ceylon Bank Chinatrust Commercial Bank Citibank N.071170436 -0.46484998 3.180688566 -0. Bank of Ceylon Intercept 1.12952215 -0.099760539 0.056994667 -0. Vol.170234103 0. Bank Internasional Indonesia Bank of America NA Bank of Bahrain & Kuwait B.122962004 0.85602603 0.01825398 1.14975198 0.A.A.14933839 -0.67527649 66 Slope (year – 2000) -0.097795861 Decision.V.V.65355986 3.003340681 0.25669266 -1.03962973 -0.20859932 -1.254839972 -0. UFJ Bank Ltd.O.81910776 0.58786894 1. Ltd.26450646 0.546836973 0. Abu Dhabi Commercial Bank Ltd.317903461 0.C.170827108 -0.004065156 -0.3569019 -1. Mashreqbank psc Mizuho Corporate Bank Ltd. No.G.000380342 -0. Shinhan Bank Societe Generale Sonali Bank Standard Chartered Bank American Express Bank Ltd.6526672 -1.90476926 0.72342022 -0.64811067 -0.17555225 -2.142932671 0.181963027 0. Deutsche Bank AG DBS Bank Ltd. JPMorgan Chase Bank Krung Thai Bank Public Co.81734051 4.101167754 -0.31614223 0.81258399 -1.131322201 0.
054047728 0.00106465 Slope (year – 2000) 0.051298616 0.26120998 0.002567629 0. City Union Bank Ltd.136967363 0.116207829 0. Lord Krishna Bank Ltd. 2010 . & International Bank Ltd. Ratnakar Bank Ltd. ICICI Bank Ltd.064499176 0.3930081 0. Dhanalakshmi Bank Ltd.041499313 0.2944575 -1.022834216 0.94772348 -0.049994341 0.165285579 0.078849531 -0.16354414 0.029449526 0.92791084 1.157153616 -0.45686237 -0. Bharat Overseas Bank Ltd. ING Vysya Bank Ltd.December. IndusInd Bank Ltd. Kotak Mahindra Bank Ltd.00207199 0.77907825 -0. Nainital Bank Ltd.052201669 0. No.088155445 -0.39861948 -0. Development Credit Bank Ltd. Ganesh Bank of Kurundwad Ltd.054821367 -0.24893592 0. Yes Bank Ltd.07924113 -1.9024303 0.172237699 0.60358398 -0.08737961 -1.3.37434084 -1.064211205 0. Federal Bank Ltd.068049803 0.187866103 Decision.Risk Analysis of Scheduled Commercial Banks of India 67 Bank Name Axis Bank Bank of Punjab Ltd.06318149 0.76263577 1.03422197 -1. South Indian Bank Ltd.009307104 -0. 37.11839628 -0.14263498 -0. Tamilnad Mercantile Bank Ltd. Catholic Syrian Bank Ltd. HDFC Bank Ltd. Sangli Bank Ltd.44559436 -1.025830225 -0. Allahabad Bank Indian Bank Intercept -1.079808103 0. Vol.01857568 -1. SBI Com. Karnataka Bank Ltd.14204964 -0. United Western Bank Ltd.79281799 -0.071330029 0. Lakshmi Vilas Bank Ltd.07393181 -0. Centurion Bank of Punjab Ltd.04296009 0.26670165 -0.22541851 0.019273651 0.12930102 -0.017307323 -0. Bank of Rajasthan Ltd.56119598 -0. Jammu & Kashmir Bank Ltd.34076787 -0. Karur Vysya Bank Ltd.108888368 0.166808533 -0.89665413 0.
055453272 -0.54760307 1.41246316 0.20568795 -0.03609515 0. Vol.54807168 0.009680742 -0.28440724 -0.054956733 -0.06543251 0.04465309 -0.218109304 -0.5010968 -0.1834861 -0.09104751 -0.0303488 0.12170812 -0.99577393 -0.047468964 -0.30754683 -0.31779953 0.028112222 -0.37051472 0.019418487 -0.025885952 0.23192512 0.038823934 0. 2010 .060739374 0.015066375 -0.011081639 -0.16652488 0.11020922 -0.01531644 -0.04944226 0.Risk Analysis of Scheduled Commercial Banks of India Bank Name Indian Overseas Bank Oriental Bank of Commerce Punjab & Sind Bank Punjab National Bank Syndicate Bank UCO Bank Union Bank of India United Bank of India Vijaya Bank Andhra Bank Bank of Baroda Bank of India Bank of Maharashtra Canara Bank Central Bank of India Corporation Bank Dena Bank State Bank of India State Bank of Bikaner & Jaipur State Bank of Hyderabad State Bank of Indore State Bank of Mysore State Bank of Patiala State Bank of Saurashtra State Bank of Travancore Intercept 0.000157753 -0.29711326 0.56459948 -0.123171697 -0.038927811 -0.13440582 0.4721722 0.18113692 68 Slope (year – 2000) 0.045853525 Decision.04858578 0.081350034 0.007253723 0.246201 0.3. No.December.143387614 0.33753742 0.050412026 -0. 37.